I went to one of those "pitch nights" a few years ago. Honestly, because I heard there was free pizza, and it seemed interesting. I think maybe 10 startups went up to practice their pitch. A few of them were really impressive and had some traction already, I was personally impressed. Who was the only one to get one of the investors business cards at the end of their pitch? The MIT kids with the only idea that didn't have a business model. I left that night feeling pretty bitter. I always felt like the great part of tech was the possibility of upward mobility, but it seemed like an illusion that night.
This is sad but true. Most of my local startups desperately want to hire students from top schools even just for short term internships to attract investors.
For better or worse, degree is a signal in a noisy world. Someone who went to MIT is on average more likely to be useful to an investor than someone who isn't. And perhaps this is true even if they have an awful demo or product. If they have tech skills, the investor can find them work elsewhere.
But in reality, pitch nights are generally garbage anyway. Investors put a lot of weight on "Who introduced the entrepreneur to me" and that carries more elitism than MIT. Again this is to get through all the noise.
If you have a project with traction and a large addressable market, the investors will follow the signal and stop worrying about pedigree.
Google recruiting would agree with you. They've de-emphasized school. :-)
My (limited) observation is it's one signal of many that is real, in a very noisy world. And 2-3 years post-graduation it's much weaker than other work related signals.
There are a couple of reasons why it's attractive to choose the MIT kids:
1) They presumably have other opportunities available to them that they gave up to pursue the venture. It's hard to gauge the passion of a founder if they couldn't have gotten a job at google instead.
2) Investors want innovative products that eventually turn into companies, which means they want smart people who have a cool idea and can tweak the model when needed rather than people who just follow a business plan. Snapchats business plan would have been horrible if they had one.
As for upward mobility, pedigree is not something you're born with. Anyone can go to MIT, Stanford, or Harvard (and they give out quite a bit of financial aid as well).
I'm not too surprised by the result - at the beginning of any new business, all you really have are the initial people on board and the quality of their abilities. What's going on now matters less than the ability of the founders to react and shift as needed.
For the tl;dr crowd, what mattered most to investors is the quality of the founding team. The paper finds that operational abilities and expertise of the founders is important. Relevant paragraph:
"Given the importance of team information, what is the channel through which human
capital information is important for early stage investors? One explanation is that the operational
or technical capabilities of the founding team raise the chance of success, especially in the earlier
stages of a firm’s lifecycle, when experimentation is important. An alternative explanation is that
high quality teams have attractive outside options, and can therefore credibly signal the quality
of the idea. We find evidence that human capital is important at least in part due to the
operational capabilities and expertise of the founders."
Measuring quality of a person is very difficult in a resume. I don't think that investors are able to identify quality people really easily. So I'm assuming they are making assumptions based on pedigree (eg: went to stanford, worked at amazon therefore must have high ability!)
"We find evidence that human capital is important at least in part due to the operational capabilities and expertise of the founders."
That's not a statement of pedigree.
"operational capabilities" basically means that investors have some way to figure out that the founders can organize labor, manage money, define the product, find customers, ect.
That's exactly what the parent was saying, investors can only draw that conclusion based on pedigree and experience. "Oh they ran the software at the warehouses in Amazon, they must be experts in that, here's $5M for your warehouse management software". Unfortunately this often gets conflated with pattern matching that doesn't always correlate with a person's pedigree and their ability to "organize labor, manage money, define the product, find customers, ect.". In other words, you're both saying the same thing.
Investors telling the public that they can appropriately assess startup teams in a 1-hour pitch is a glittering lure to increase deal flow, not something that makes one investor necessarily smarter than an other.
"Oh they ran the software at the warehouses in Amazon, they must be experts in that, here's $5M for your warehouse management software"
That's only 1/3rd; the other 1/3rd is "Successfully founded xyzCorp that had $xxxx / year revenue and sold for $x,xxx,xxx after 5 years."
Investing in a founding team where the founders have a solid history of starting successful companies isn't relying on pedigree.
The final 1/3rd is looking at the team dynamic during a pitch. Is the team on the same page? Are they happy with each other? Does one person do all the talking?
I helped make Amazon a billion dollar company. Really. Is that a successful exit even though I wasn't a founder of Amazon?
You don't really know because you don't know if I was a warehouse employee hired for a holiday season or if I was instrumental in something in the early days.
Obviously investors are funding people without prior exits where they were founders, otherwise there would be a chicken and egg problem.
I would like to see stats as to the number of "successful exits" the average founding team that raises an A round has.
But clearly I should emphasize the exits on the pedigree slide of our pitch deck.
In my experience I've found little correlation between pedigree and quality. This isn't a randomized study, but my experience for 30 years working for and founding (sometimes random) startups. The school one goes to and the companies one has on their resume do not mark a great employee or founder. Talent or ability and willingness to work hard and take responsibility are important.
At the same time, there are a lot of companies that fail into success-- where the market is right and the funding is sufficient that they can make mistake after mistake and still end up being successful.
So I think the part of the abstract that claims that this is "rational" to fund based on pedigree is confusing correlation for causation-- if people with pedigree but no ability tend to get a lot more funding than people with the same lack of ability but no pedigree, obviously more of them are going to be more successful. And the people with ability whether they have pedigree or not, may be more successful overall, but this study isn't controlling for that. (and it's hard to identify ability, that's for sure.)
I think this is a serious problem in various areas of society, and touches on the debates regarding the value of a degree or certification.
I have no doubt that pedigree, as you refer to it, does stochastically index quality. There's too much evidence from various studies that it does. But the strength of relationship between pedigree and quality, is much, much, much weaker than people typically assume. We end up relying on things like test scores in school, and degree in the workforce as a proxy for talent or ability or motivation or whatever, when it's more like a weak predictor. In the process, we end up granting monopolies to meritocracies and driving up things like income inequality, where income distributions don't parallel skillsets.
I agree that this paper probably reinforces false beliefs, but my guess is that it does so because it oversimplifies a kernel of truth, not because there's no truth to it to begin with.
I don't think it's as much about pedigree (school especially) as it is what you're leaving on the table to do the startup. It's a strong signaling factor if a Fortune 500 VP leaves to start something new, versus someone who was an Analyst at a bunch of small companies. The VP is presumably leaving a lot of money on the table for the idea - its skin in the game measurable in opportunity cost.
>Talent or ability and willingness to work hard and take responsibility are important.
In reading the paper, that seemed to be the other factor in the human capital evaluation. Investors need to feel good about the abilities of the founders.
Both VP and rank-and-file are leaving a lot on the table - their entire income. If anything it's easier for a VP due to their savings stretching farther and their passive investments.
If I got a buck for every startup story of the form "When I was a freshman at Stanford...", I could probably afford to go to Stanford.
On the upside, there's a juicy chance here for canny investors to try and find underpriced opportunities of the form "When I was working at the video store ..."
Maybe it's much more of a social decision than a business decision.
Early stage investors are gambling even more than late stage investors. The best they can hope for is to find 50 reasonable deals and let the math work itself out.
So the better part of their decision could easily be based much more on what their peer early stage investors think of them. Founders with pedigree are easy to justify and obviously more socially valuable than founders without pedigree (like buying IBM). So being the angel who keeps getting those founders means other investors will look up to you.
And, if things go wrong, nobody can blame an investor for getting into bed with pedigreed founders. It's an obvious decision, so it won't invite ridicule. Since it's obvious, there will be more competition, and that's something the angel doesn't have to rely on luck to win.
I found this paper in the references of a previous similar paper discussed on HN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2801385
I am using it to write a chapter of my dissertation. Here are some relevant quotes from the paper.
TLDR:
>> Introduction
Start-up firms are particularly difficult to finance because their prospects are highly uncertain, they lack tangible assets that can be used as collateral, and they face severe information problems (Hall and Lerner (2010)). Given these problems, how do investors choose which start-ups to fund? What factors drive their selection process? (…)
This paper provides, to the best of our knowledge, the first experimental evidence of the causal impact of start-up characteristics on investor decisions. (…)
Based on competing theories of the firm, we focus on three key characteristics of start-ups: the founding team, the start-up’s traction (such as sales and user base), and the identity of current investors. (…)
We sent approximately 17,000 emails to nearly 4,500 investors on the platform, spanning 21 different start-ups, during the summer of 2013. The randomized experiment reveals that the average investor is highly responsive to information about the founding team, whereas information about traction and current investors does not lead to a significantly higher response rate. This suggests that information about the human capital of the firm is uniquely important to potential investors, even after controlling for information about the start-up’s idea. (…)
We find that the more experienced and successful investors react strongly only to the team information, which provides indirect evidence of the viability of an investment strategy based on selecting on team information.
>> Why do Investors React to Information on Founding Team?
We find evidence that human capital is important at least in part due to the operational capabilities and expertise of the founders. (…)
>> Is it Rational to Invest Based on Founding Team?
It is challenging to answer this question directly, for several reasons (…)
We can, however, take an indirect approach by exploring how successful and experienced investors react to various information (…)
The inexperienced investors with no prior investments, who make up 18% of the sample, react not only to the team information, but also to the traction and current investors.(…)
The experienced investors still only respond to information about the team, while the significance of the response to the traction and current investors categories among inexperienced investors weakens somewhat.(…)
>> Conclusion
Overall, the results in this paper present evidence for the causal importance of human capital assets for the success of early stage firms, and contribute to the debate around the importance of various key assets to organization success. Our results, however, do not suggest that non-human assets are not essential. Rather, the results are consistent with the model by Rajan (2012), in which human capital is initially important for differentiation, but needs to be replaceable in later stages so that outside investors can obtain control rights, thus allowing the firm to raise large amounts of external funding
With a quick glance, I got an impression that it wasn't a survey, but this was an actual experiment. They sent 17000 randomized emails to 5000 early-stage investors through AngelList. Emails highlighted either the team, traction, existing investors or some combination of these. Researchers measured how many investors responded with "View" or "Get an Intro" buttons.
I think that is pretty well designed experiment given the difficulty of researching such topic.
I think a tl;dr would be that early stage investing is more of a social decision about who and what you want to help than a rational decision ala the mythical "homo economicus."
I think that suggests that the initial concept and the product that eventually follows will eventually diverge. More emphasis is put on the people steering the ship when you need to change direction, and if I had to guess, investors presume that a change of direction is very likely to happen.
Yeah, and I assume there are limits to the indifference to traction too. If you stumble in reeking of pot and looking like you haven't bathed in a week but you have 300% CMGR I imagine something might still happen.
Definitely. The truth of the matter is that most early stage startups don't have much traction, so trying to split those hairs isn't as important as evaluating the founding team.
Take this for what it's worth from my experience working at various organizations, but in some investment circles, the importance of the management team matters even with large organizations. Berkshire Hathaway, for instance, weighs the strength of management very highly when deciding where to invest, because like an early stage investment model they are largely situated to leave the businesses to manage themselves and provide support in an advisory capacity. I started early in my career at one of Berkshire's best bets (GEICO) not long after Buffett bought the rest of the company. Back then at least, he was the kind of guy that visited and talked to the employees a couple times a year, (even the peons like me), and he was very candid on valuing strength of management very highly in investment decisions. Yes, it was a contrarian bet to buy an insurance company that had almost gone out of business, but he was confident in the ability of the management team. I've been all over the insurance industry, and objectively speaking, that's the best run company I've ever been at, and their growth and market position from 1996 to today would reflect that. And they're not my current employer, btw.
Sorry for adding noise to the signal, but I want to say what a pleasure it was to click the link, read the abstract, then click "PDF in Browser" to read the full article.
No "$40 for a day" overlays, no searching for the authors' websites to get a preprint version. Just one person with his curiosity satisfied. Thank you to whoever paid for it.
"This paper uses a randomized field experiment to identify which start-up characteristics are most important to investors in early stage firms. The experiment randomizes investors’ information sets of fund-raising start-ups. The average investor responds strongly to information about the founding team, but not to firm traction or existing lead investors. We provide suggestive evidence that team is not merely a signal of quality, and that investing based on team information is a rational strategy. Altogether, our results indicate that information about human assets is causally important for the funding of early stage firms, and hence, for entrepreneurial success."
